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2d 978
8 Collier Bankr.Cas.2d 457, 10 Bankr.Ct.Dec. 275,
Bankr. L. Rep. P 69,088
$26,158.95 he received from Roco was a voidable preference. For the reasons
discussed below we affirm the bankruptcy court's judgment as affirmed by the
appellate panel.
I. Facts and Proceedings Below
2
Consove and his partner Arthur Rosen incorporated Roco in 1946; each one
owned fifty percent of the company's outstanding stock. Roco, doing business
as Standard Supply Company, operated a hardware supply business. Consove
was the "inside man" who took care of purchases and accounts receivable while
Rosen handled sales. The company appears to have been a marginal one, but
generally paid its bills as they came due and provided reasonable salaries for
Consove and Rosen.
Rosen died in February 1978 and Roco redeemed his stock for approximately
$130,000, funded in part by insurance proceeds.1 As a result of this redemption
Consove became the sole shareholder of Roco. Soon thereafter Consove and
his son Gerald discussed the possibility of Gerald taking over the business and
Consove retiring. Gerald had been a full-time employee of Roco since 1970 and
a part-time employee before that. During these years Rosen had displayed little
confidence in Gerald's ability to manage the company and Gerald had not been
given any position of responsibility or ownership.
Consove and his wife then retired to Florida. He apparently had little contact
with Roco, other than receiving $600 weekly interest payments, until January
1980 when Gerald telephoned to request a $15,000 loan to cover the company's
cashflow shortfalls caused by slow collections of accounts receivable. Consove
loaned Roco the amount requested. Apparently this situation was not unusual:
Consove had made such loans to the company during the years he had managed
it. He cashed a check in full payment of this latest loan on June 13, 1980.
A fire in June 1980 forced Roco to close its warehouse. Consove returned to
Rhode Island in July when his weekly payments of $600 stopped; up to this
point he had received interest payments totalling $21,600. Consove took back
control of the business from Gerald and soon confirmed his suspicion that his
son had been mismanaging Roco and diverting its funds for personal use.4
Consove confronted Gerald about this diversion of funds and had him execute a
personal note of $27,000 to the order of Roco. In his capacity as Roco's
president Gerald endorsed this note to Consove. It has not been paid.
Between the time Consove reassumed control of Roco and September 23, 1980,
the date an involuntary bankruptcy petition was filed, he caused the corporation
to issue him six checks totalling $36,886.69. According to Roco's books,
$26,159.95 of this amount was applied to the balance due Consove for officer
loans and the remaining $10,727.74 was applied to reduce the principal balance
on the $300,000 note to $289,272.26.
After the filing of the bankruptcy petition, Consove filed a complaint to modify
the 11 U.S.C. Sec. 362 automatic stay to permit him to continue exercising his
rights as a secured creditor, specifically to reclaim Roco's assets. In his answer
the Trustee asserted several affirmative defenses and counterclaims. The
bankruptcy court rendered a judgment for the Trustee based on the affirmative
defense of fraudulent transfer and on his counterclaim seeking avoidance of
preferential transfers under 11 U.S.C. Sec. 547. The appellate panel affirmed
the bankruptcy court's findings and conclusions on the issues of the fraudulent
transfer and preferences. The panel vacated the court's order that Consove turn
over to the Trustee Gerald's $27,000 note because there was no support for it in
the record and remanded that issue for appropriate proceedings.5 The Trustee
has conducted a public auction of Roco's hardware inventory and is holding the
proceeds as well as the estate's remaining assets pending the outcome of this
case.
The bankruptcy court held that the transfer by Roco of the $300,000 note and
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interest it gave Consove. Indeed, Roco received nothing but all of its
outstanding stock. We agree with the bankruptcy court that this stock was
virtually worthless to Roco.7 Under generally accepted accounting principles
this treasury stock would be reported on the balance sheet of Roco as a
reduction of stockholders' equity, not as an asset. See generally R. Anthony & J.
Reese, Accounting Principles 215 (4th ed. 1979) ("Treasury stock is clearly not
an 'economic resource' of an entity."). As the appellate panel noted, treasury
stock is a form of shareholder distribution from which the corporation receives
no assets. When a corporation purchases treasury stock it reduces its
capitalization.8 Consove argues that the implication of this accounting theory
when incorporated into the section 548(a)(2)(A) analysis is that no stock
redemption could pass muster under this section. We disagree. It is possible, for
example, that a publicly traded corporation with many shares outstanding could
redeem a fraction of these shares, perhaps to fund an executive benefits plan or
to use in converting convertible bonds or preferred stocks, and receive value as
defined in the Bankruptcy Code that would be reasonably equivalent to what it
transferred.9 The implication of the bankruptcy court's holding is merely that
when a corporation with one shareholder redeems all of its outstanding stock,
the value of this stock in the hands of the corporation is at best questionable.
12
Consove argues that the only proper measure of the value of the shares
transferred to Roco in this redemption is the value of the ownership interest that
he forfeited. Even if we were to accept this proposition, and ignore the clear
language of section 548(a)(2) that the value to be considered is that received by
the debtor and not that forfeited by the transferee, we would still hold that the
district court properly found that Roco received less than reasonably equivalent
value. Consove points to the Rosen redemption in 1978 as evidence of the
value of Consove's ownership interest on November 1, 1979. If we assume that
the value of Rosen's stock was $130,00010 the maximum value of Roco at the
time of this redemption would have been $260,000, and after paying for
Rosen's shares the value would have fallen to $130,000. Financial statements
included in the appendix to Consove's brief filed with this court indicate that
Roco's net income for the next two fiscal years totalled less than $30,000--not
nearly enough to raise the value of the corporation to the $300,000 face value
of the note. Despite Consove's statements to the contrary, we have seen no
evidence to rebut the Trustee's prima facie case that reasonably equivalent
value is lacking here. Perhaps the best available evidence as to the true worth
of Roco on November 1, 1979, when Consove redeemed his shares and retired
from active management of the company, was the $3,000 supposedly paid by
Gerald for 100% control.
13
We turn next to the bankruptcy court's finding that the redemption of Roco's
Consove maintains that the court erred in its reliance on unaudited financial
statements because these statements did not accurately reflect the fair value of
the company's assets. We have held, however, that unaudited financial
statements may be admissible as the best available evidence and that it is for
the trier of fact to assess the accuracy of such statements. Braunstein, 443 F.2d
at 1284. Consove argues that the unaudited balance sheet is inaccurate for the
purpose of determining insolvency because it reflects historical costs and not
fair values. For several reasons, however, this historical cost balance sheet
approximated the fair value of Roco's assets with sufficient accuracy. First, the
balance sheet of Roco was dominated by current assets; for example, cash,
accounts receivable, and inventory amounted to over $726,000 of the total
assets of $756,439.54 on January 31, 1980. The balance sheet reflected no fixed
assets, those assets most affected by the inaccuracies of historical cost
accounting. Second, the accounts receivable may actually have been
overvalued as there did not appear to have been a reserve for doubtful accounts.
Third, and most importantly, there was evidence that the inventory, which
amounted to $529,647.08, was not valued at the lower of cost or market as
required by generally accepted accounting principles. Instead, the inventory
was reported at either retail sales price or the prior year's cost, whichever more
accurately reflected fair market value. The bankruptcy court clearly did not err
in relying on Roco's unaudited balance sheet to determine that the company
was insolvent.
15
Finally, Consove argues that the court erred by not including $100,000 for
goodwill in the value of Roco's assets. He correctly states that the fact that
goodwill was not disclosed on Roco's balance sheet does not mean that the
company did not possess goodwill. Typically goodwill will not be reported on a
balance sheet unless there is hard evidence of its existence and value--for
example, a balance sheet might reflect the goodwill of a subsidiary which a
parent corporation has purchased by paying an amount in excess of the fair
Having found that the bankruptcy court did not err in holding that the
redemption of Consove's shares of Roco was a fraudulent transfer under section
548(a)(2), we would not normally reach the issue of actual fraud under section
548(a)(1). Like the appellate panel, however, we find that we must address this
issue because it plays an integral role in analyzing Consove's claim that he has
a valid lien under section 548(c) for any value he actually transferred to Roco.11
There is a question of whether we should consider this section 548(c) issue
because it was not raised before the bankruptcy court; Consove argues that it is
not a new issue and that the bankruptcy court should have considered it sua
sponte once it found the redemption to be a fraudulent transfer. In any event,
we have little trouble finding that the bankruptcy court did not err in its finding
of actual fraud and, as a result, that Consove does not have a valid lien under
section 548(c).
17
A court may make a finding of fraudulent intent under section 548(a)(1) on the
basis of circumstantial evidence; direct proof of the transferor's fraudulent
intent will rarely be available. 4 Collier on Bankruptcy, supra, p 548.02, at 54833. We may impute any fraudulent intent of Consove to the transferor Roco
because, as the company's president, director, and sole shareholder, he was in a
position to control the disposition of its property. See id. at 548-30. The
substance of the redemption was that the father passed along the ownership
interest of Roco to his son and secured for himself a steady retirement income
at his prior salary level, all at the expense of the corporation's creditors. As the
appellate panel noted, the stockholder's claim became superior to the claims of
trade creditors with the latter receiving no value, but instead having their
interests severely impaired. The large discrepancy in value between the note
transferred and the stock received strengthens the inference of fraud. See id. at
548-37. We cannot say that the bankruptcy court was clearly erroneous in its
factual finding of actual fraud. Consove's argument that his $15,000 loan to the
corporation in January 1980 evidences his lack of fraudulent intent with respect
to creditors is unpersuasive. At this time Consove had a strong motivation to
assure the continued operation of Roco because it represented his source of
retirement income and his son's source of employment. Fraudulent intent does
not require an intent to run the company aground; it requires merely an intent to
Consove's claim that he is entitled to the saving benefit of section 548(c) must
fail once we have found that the bankruptcy court was not clearly erroneous in
its finding of actual fraud. Good faith is an "indispensable element" of this
saving benefit provision. Id. p 548.07, at 548-61. Although the good faith
requirement here is not susceptible of precise definition, id., surely a finding of
actual fraud under section 548(a)(1) precludes any opportunity for a lien under
section 548(c) to the extent of any value given.
III. Preferences
19
As noted earlier, between the time he regained control of Roco and the date the
bankruptcy petition was filed, Consove had the corporation issue him checks
totalling $36,886.69. The bankruptcy court held that the $26,158.55 of this
amount that was applied to the balance due Consove for officer loans was a
preference under section 547(b).12 It follows from our finding that the
bankruptcy court did not err on the fraudulent transfer and section 548(c) issues
that it also did not err in its conclusion that the payments here constituted a
preference; these payments clearly fall within section 547(b) because they
enabled Consove to receive more than he would have otherwise received under
chapter 7.
IV. Conclusion
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Affirmed.
The bankruptcy court noted that loans Consove made to the business prior to
November 1, 1979, had been unsecured
Consove concedes that this amount was incorrect and that the actual balance
due him on the date of the redemption for officer loans was $26,158.95
The appellate panel noted that it is unclear under what authority Consove
regained control. Consove maintains that he merely was exercising his rights
under the security agreement executed when his stock was redeemed.
Consove's Amended Complaint to Modify Stay, however, states that he did not
give notice of exercising his rights as a secured creditor until about two months
after he assumed control
The appropriate disposition of this $27,000 note has not been raised by the
parties on appeal
For cases holding that shares of stock sold back to the corporation were
valueless, largely due to the insolvency of the corporation, see Schafer v.
Hammond, 456 F.2d 15, 17-18 (10th Cir.1972); Lytle v. Andrews, 34 F.2d 252,
253-54 (8th Cir.1929); M.V. Moore & Co. v. Gilmore, 216 F. 99, 100-01 (4th
Cir.1914)
8
On its corporate income tax return for the taxable year ended January 31, 1979,
a photocopy of which was included in the appendix to Consove's brief filed
with this court, Roco reflected the cost of Rosen's redeemed stock as a
reduction of stockholders' equity on its Schedule L Balance Sheet. Although
one might argue that Roco had no choice as to how to report the cost of
treasury stock on its return, Schedule L requires a taxpayer to disclose balance
sheet information as recorded on its financial records. It is evident that the
schedule was designed to approximate reporting in accordance with basic
generally accepted accounting principles, and that Roco apparently understood
the requirements of these principles with respect to reporting the cost of
treasury stock when it prepared this return. Moreover, the corporation's balance
sheet as of January 31, 1980, reflects the cost of both Rosen's and Consove's
redeemed shares as a reduction of stockholders' equity and not as an asset. This
manner of reporting reveals the economic substance of treasury stock
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